21/8/2014: Capital v Labour Taxes: Time to Scratch that Cabbage Head, Mr. Politico

Ireland, like majority of other small open economies, runs a tax regime that is punitive to highly skilled workers and benign to capital owners. This, as I explain in part here (http://trueeconomics.blogspot.ie/2014/08/2182014-thomas-piketty-powerful.html), spells bad news for wealth distribution. It is simply a tax transfer from one form of capital (human capital) to other forms of capital (financial, IP and physical capital). Still, majority of small economies around the world continue to argue in favour of skinning alive their human capital and subsidising (in either relative or absolute terms) other forms of capital, based on a simple argument: in modern world, financial, IP and technological forms of capital are highly mobile (tax them and they will run for the border, goes the argument), even physical capital is mobile over the long run (tax it and investment will flow somewhere else), while labour is tied to its chair by the chains of visas, work permits etc (tax workers and they have nowhere to go).

Of course, in the real world, labour is mobile and highly skilled labour is highly mobile. That is something our outdated, outsmarted and out-of-touch political classes do not comprehend. But some academics do. Here's an example: Aghion, Philippe and Akcigit, Ufuk and Fernández-Villaverde, Jesús, paper, titled "Optimal Capital Versus Labor Taxation with Innovation-Led Growth" (May 31, 2013. PIER Working Paper No. 13-025. http://ssrn.com/abstract=2272651) shows that in presence of mobile labour force, capital subsidies are suboptimal from the revenue point off view. And worse, the more innovation-driven is your growth (the more reliant it is on human capital and the more mobile that human capital is), the lower is efficiency of capital supports.

"Chamley (1986) and Judd (1985) showed that, in a standard neoclassical growth model with capital accumulation and infinitely lived agents, either taxing or subsidizing capital cannot be optimal in the steady state. In this paper, we introduce innovation-led growth into the Chamley-Judd framework, using a Schumpeterian growth model where productivity-enhancing innovations result from pro.t-motivated R&D investment."

Enough of mumbo-jumbo. "Our main result is that, for a given required trend of public expenditure, a zero tax/subsidy on capital becomes suboptimal. In particular, the higher the level of public expenditure and the income elasticity of labor supply, the less should capital income be subsidized and the more it should be taxed. Not taxing capital implies that labor must be taxed at a higher rate. This in turn has a detrimental effect on labor supply and therefore on the market size for innovation. At the same time, for a given labor supply, taxing capital also reduces innovation incentives, so that for low levels of public expenditure and/or labor supply elasticity it becomes optimal to subsidize capital income."

Of course, labour supply is even more income elastic when it is related to high quality human capital (that can be marketed internationally), and worse, when it is related to innovation (the one that is sought after by dozens of advanced economies bidding over each other to attract the right talent in).

Now, give it a thought:
* Irish tax system literally destroys returns to human capital through punitive levels of taxation of returns on high skills;
* Irish labour markets are open to migration (including emigration of highly skilled);
* Irish economy competes for high skills with scores of other similar economies; and
* Irish state is subsidising in relative terms returns to physical and financial capital, while our tax codes also subsidise IP returns.

Time to scratch that cabbage head, Mr. Politico?

26/09/2011: Youth unemployment problem

The latest QNHS data for unemployment in Ireland - discussed in detail here - was not a pretty picture by any means. But the ugliness of age-breakdown in unemployment is something else altogether.

Now, recall that Ireland is a young country. Per CSO, 1.5% of our workforce is age 15-19, 6.7% age 20-24, 28.9% age 24-35 and a full 37.1% of the workforce is aged less than 35. This has many good implications for the economy and the prospect for future growth, but it also places some tough demands on the economy. You see, young people are quite pesky subjects. They (unreasonably - from our, older folks point of view) want in life:

• Improved prospects for the future as far as their careers, earnings, quality of life etc go,
• Good chances for beating their parents performance in terms of gaining jobs and progressing up the career ladders,
• Ability to enjoy some of younger years' offers of decent consumption, comforts of some certainty in life, while earning returns to their efforts and education.

Not exactly an easy bunch to satisfy, younger people tend to be more mobile. And the greater their skills set / potential, the more they invested in education or training, the more mobile they are. This is why, in my view, the idea of the 'demographic dividend' is a bit of a silly old hat - the dividend is there (or rather here, in Ireland) if and only if the asset is here.

But the QNHS data does not lie (well, kinda - it does lie in so far as it underestimates true extent of unemployment by omitting those over-extending their education and training in the absence of jobs). The assets we have in the form of our younger people are... err... extremely highly jobless, pretty much deprived of hope of gaining any of the above points.

Here are some stats, all from QNHS for Q2 2011.
Overall,

• 38,400 males of age 15-24 and 116.2 males of age 25-44 were unemployed in Q2 2011
• 25,100 females aged 15-24 and 53,900 females of age 25-44 were also unemployed in Q2 2011

However, these absolute numbers do not tell the entire story as the size of the labour force itself has been changing over time (shrinking). In terms of unemployment rates:

• Overall unemployment rate for those under the age of 20 is now at 40.1%, implying that a person aged 15-19 who wants to be employed is facing 2.8 times higher probability of not having a job than an average person in the workforce. For the age group of 20-24 years of age, these numbers, respectively are 27.7% and 1.94 times. For those in their prime employment years - 25-34 year olds - the numbers are 16.5% and 1.16 times.
• A woman of age 15-19 is facing unemployment rate of 33.7%, while her slightly older counterpart of age 20-24 is facing probability of unemployment of 21.8%.

Dramatic as the above figures are, the picture is much worse for males:

• A young male of age 15-19 seeking employment is facing unemployment rate of 46.1%, while a male of age 20-24 is facing the prospect of 33.7% unemployment. Unemployment amongst males age 25-34 is 21.5%.

This is desperate, folks. But it gets worse. per Table S9b in QNHS, in Q2 2011, of all persons aged 18-24:

• 79% of all early school leavers were either unemployed or not economically active a number that rose from 77% in Q1 2011
  
• 59% of all other persons in this age category were either unemployed or not economically active, same as in Q1 2011
  

For comparison, for all persons 25-64 years of age, the above numbers were:

• 55% of all early school leavers either unemployed or not economically active, up from 54% in Q1 2011
  
• 27% of all other persons either unemployed or not economically active, down from 28% in Q1 2011.
  

This is a dire prospect for our 'demographic capital', folks, as it shows that the gap by age for even educated unemployed is a vast 22 percentage points - statistically most likely indifferent from the same gap for those with little or no education.

25/09/2011: Returns to Education in Europe

CEPR working paper No. 8568 (link) "RETURNS TO EDUCATION ACROSS EUROPE" by Daniela Glocker and Viktor Steiner, published last week, provides some interesting (and intuitively consistent) evidence on the overall structure of the market returns to education.

Education is generally considered to be a key driver for economic growth and as such forms a specific target in many policy programmes for growth and development, such as the Europe 2020 strategy.

Since the seminal work of Gary S. Becker (starting from his 1960s papers) from an economic perspective, "the optimal level of education depends on the returns to education". Individuals invest in education if the life-time returns to education exceed the cost. These returns drive at least some of the differentials in education outcomes found across the countries. The CEPR study compares "the private returns to education across selected EU countries to explain cross-country differences in educational attainment."

The analysis is based on the 2008 panel data from the EU Statistics on Income and Living Conditions (EU-SILC) which provides comparable micro data for the member states of the European Union. The authors "estimate separate augmented Mincer-type wage equations for Austria, Germany, Italy, Sweden and UK, countries which differ significantly regarding both their education system and labour market structure."

"While the Austrian and German educational system are broadly similar and differ significantly in terms of enrollment rates in higher education from the other countries considered here, labour market outcomes in the two countries are quite distinct. Whereas Austria's unemployment rate is persistently one of the lowest in the European Union, Germany has one of the highest rates. Italy also features a relatively low enrollment rate in tertiary education, but does not have the system of vocational training prevailing in Austria and Germany which is said to be an important factor contributing to the relatively low levels of youth unemployment in these two countries. While Sweden and the United Kingdom both have relatively high enrollment rates in higher education, its financing differs significantly between these two countries and they also differ markedly in terms of labour market outcomes."

Table below - reproduced from the paper - summarizes some of the difference in outcomes across various countries.


The study estimates returns to education by country and by gender. Across countries the study finds that:

• The direct effect of education on wages is positive and significant for all countries.
• Education has a negative effect on unemployment duration, with effect being the strongest in Germany, and lowest for Swedish men where it is not statistically significant.
• The probability of an unemployment spell is lower by up to 23 percentages points, for those with 16 years of education (university level) relative to those with nine years of education (basic education). The highest decrease in probability of unemployment spell is observable for German and Austrian men, and the lowest for Swedish men and women.
• Similarly, the unconditional expected length of the cumulated unemployment declines with education. "For German men the decrease in the expected unemployment duration is the highest with six months, and the lowest for Swedish women"
• Wage decreases due to time spend in unemployment reduce hourly wages in Germany, Austria and Italy, so that "education has an indirect effect on wages in these countries."
• "The returns to education are positive and significant for men. Comparing the gross returns to education across countries, the UK has on average the highest returns to education with an increase in the hourly wages by 9 percent with an additional year of education. Sweden has the lowest gross returns to education with 4 percent."
• "The effect of the expected cumulated unemployment duration is negative, but not statistically significant for Sweden and the UK. Although the level of schooling has a significant effect on the cumulated unemployment duration in the UK, the expected cumulated unemployment duration itself has not a significant effect on wages. The indirect effect of education on wages through the channel of the cumulated unemployment duration is the highest for Germany."
• Focusing on the net returns broadly confirms the above results for gross (pre-tax) returns. "A slight change occurs when comparing Austria and Germany. While Austria has slightly higher gross returns (7.2 percent compared to 7 percent), Germany has with 6 percent 0.2 percentage points higher net returns. Looking how the returns to education change when comparing gross and net hourly wages, the UK has, on average, the highest reduction, i.e. by roughly 2 percentage points. In Austria, Italy and Germany, the respective net returns are approx. one percentage point lower than the gross returns. Sweden shows the smallest change with 0.7 percentage points. Interpreting this difference between gross and net returns as the "social return to education", the UK benefits the most from a high level of education in the population."
• "For women [data shows] significant positive returns to education as well. As for men, the cumulated unemployment duration is significant for Austria, Germany and Italy. The combined gross as well as the net returns to education is highest for UK and Austrian women with 9 percent (and 7 percent when considering the net returns). As for men, Swedish women are estimated to have the lowest returns with respect to education."
• "Comparing the returns of education by gender across countries, [the study] finds that there are no significant gender differences in the UK. While the returns are slightly lower for women in Germany and Sweden than for their male, the opposite is true for Austria and Italy."